Afternoon,

How does a small business come about it’s valuation for sale?

If it makes £150k a year profit how does that equate?

Ash

That depends on a lot of things.
For starters – does it pay everyone who works for it at the going rate, or are there directors who work for it for a small salary and receive dividends out of the profit.

It’s usually done on a multiple of net profits.

All sorts of things can affect the multiplier – sector, all the stuff that Tom mentions, etc .

As above, with things like how predictable future income is being particularly important. So a shop with one year trading history is worth less than one with ten years of constant growth but that is worth less than one with contracts that guarantee an income for the next three years.

Balance sheet assets (buildings, IP, meaningful r&d etc.) can all add to the value but of course liabilities (debt or risks) will detract from it.

It is not an exact science though and depends what people are prepared to pay for it. Two or more keen buyers will push the price up, esp if it compliments their existing offerings. It also depends a lot on sector – tech businesses are often worth way more than profit would suggest. And finally it can also depend on who is selling and why, e.g. If a single shareholder who wants to retire then an earn out over s few years can be easier than if there are many stakeholders, especially if some of those are key employees you need to retain.

It really depends on a number of factors. Years of profitability, growth and growth potential, why it’s being sold? Does the £150k profit include or exclude all payments to directors etc… I’ve seen valuations from 2-4 EBITA to 20 times depending on the business.

From my times doing M&A, mainly based value of capital+assets, plus a factor x net profits and finally goodwill. The profit factor is based upon trading history and likely profits going forward – a short-term business will have a lower factor than one with say a good order book. Goodwill is down to things like brand and other intangibles – quite tricky for a small business. Generally a good business is 4-6x earnings, 10+ only for something with big growth or sustainability.

^^ that, all of that plus Pipeline (what’s the sales book look like and it’s projections)

what’s the sales book look like and it’s projections

Although everyone will try and ‘fluff up’ the pipeline before a sale / IPO. Just look at Autonomy….

Goodwill is down to things like brand and other intangibles – quite tricky for a small business.

yup, and usually drops to zero for a small business. Instant loss of goodwill if it’s a one man band and that man changes.

mainly based value of capital+assets, plus a factor x net profits and finally goodwill.

Technically that’s not quite right at least from an accounting point of view – that ‘factor x net profits’ is part of goodwill – i.e. anything you pay over and above the actual value of the net assets* you acquire is goodwill.

*Admittedly, that in itself ain’t an exact science.

Pick and choose:
http://exitadviser.com/business-value.aspx?id=business-valuation-methods

You investing, buying, selling or raising? What kind of business?

In many cases the real world market trumps theoretical models. e.g. Pre revenue tech/drug/xxx co, with valuable team / users / traction / IP etc and multiple potential acquirers fighting for a piece.

I’m interested in purchasing a business that’s 10 years old , has had growth (from seeing the abbreviated accounts) each year.

I’ve seen valuations from 2-4 EBITA to 20 times depending on the business.

Even 2 might be high for a small business depending on things like how key to the business the current owner was and whether or not that £150K profit was after the current owner (assuming they worked in the business) took a reasonably decent salary.

I wouldn’t place much value on abriviated accounts. Assuming it’s not simply a coffee shop or similar you want to see invoices, repeat custom, churn rate / attrition, av time to pay / defaults etc. Compare this to cash flow and what data is on the annual accounts – does tell the same story? Place your own value on current team and take into account if they are leaving or staying – will / could revenue fall off a cliff as a result? Are big invoices / claimed growth for one off projects scalable / repeatable? Could a rent increase kill the margin? If staff are staying can you afford to keep them if there is a drop in revenue – what are their contracts like – could you afford their redundancy payments. I see many local businesses that are valued based on no of years running / claimed customer base etc that I wouldn’t value at even 1x revenue. If you need a loan to finance there may even be friendly help at your local bank free of charge / local accountant and/or lawyer may help with cheap intro session in return for future business (I’m assuming you don’t have the ££ to throw at advisors / accountants / lawyers etc).

Can you start the same type of business ‘next door’ for less?

Wow, singletrack delivers again. Some great advice on this thread